Annuities as bond surrogate

[mass_biker]

Has anyone considered the use of deferred annuities or SPIAs in favor of fixed income in their taxable portfolios?

Our tax advantaged (401k, 403b etc,) portfolio is 100% equities.
Our taxable portfolio is split 50/50 equities and munis.
High 7 digit portfolio in total ex real estate. Good likelihood of future portfolio growth from here given job prospects and age (late 40s).

We've enjoyed the buffer munis have given in times of market volatility as well as the ongoing (tax advantaged) income stream.

I've read the many arguments of SPIAs as a longevity hedge (and my parents - late 70s - recently bought one that they are enjoying).

But wondering if other folks out there who have considered buying a simple annuity as a bond surrogate in their overall portfolio. SPIA rates at my age (late 40s) aren't great. A relatively simple deferred annuity (say - one that kicks in 8 years from now) does offer a better rate though. In no circumstance am I assessing VULs etc. - just wondering if there are aspects of annuities that have made them a part of someone's asset mix before the typical consideration of SPIA in your 70s.

Thanks in advance

m_b

[petulant]

Has anyone considered the use of deferred annuities or SPIAs in favor of fixed income in their taxable portfolios?

Our tax advantaged (401k, 403b etc,) portfolio is 100% equities.
Our taxable portfolio is split 50/50 equities and munis.
High 7 digit portfolio in total ex real estate. Good likelihood of future portfolio growth from here given job prospects and age (late 40s).

We've enjoyed the buffer munis have given in times of market volatility as well as the ongoing (tax advantaged) income stream.

I've read the many arguments of SPIAs as a longevity hedge (and my parents - late 70s - recently bought one that they are enjoying).

But wondering if other folks out there who have considered buying a simple annuity as a bond surrogate in their overall portfolio. SPIA rates at my age (late 40s) aren't great. A relatively simple deferred annuity (say - one that kicks in 8 years from now) does offer a better rate though. In no circumstance am I assessing VULs etc. - just wondering if there are aspects of annuities that have made them a part of someone's asset mix before the typical consideration of SPIA in your 70s.

Thanks in advance

m_b

Not a good idea at this point since it will complicate tax strategy in crucial years 60-70. You want flexibility to make ideal tax choices with IRA conversions and delay SS or otherwise based on circumstances and goals. An annuity of any kind will either be high fees or cause taxable income in a disadvantageous way.

I would also recommend a glidepath to more bonds in the 401(k) to control future IRA conversion/RMD tax liability.

[furwut]

Has anyone considered the use of deferred annuities or SPIAs in favor of fixed income in their taxable portfolios? ...

Many have. Wade Pfau has written extensively on the subject.
A Retirement Expert Says Annuities Are Better Than Bonds for Guaranteed Income. Here's His Argument.

And there is a whole school of thought to meeting retirement income needs called ‘Safety First’ that emphasizes annuities.
‘Safety First’ Income Plans, Per Wade Pfau

EDIT: Low interest rates and a poor mortality credit makes purchasing an annuity unappealing for many at younger ages. It is often said the best annuity to buy is using one’s investments to delay Social Security to age 70.

[JoMoney]

I've considered it. I'm not sure what I will do when I start moving towards a withdrawal phase, but every time I look at SPIA vs Bonds the SPIA looks more attractive to me ( I have no particular desire to leave a bequest ).
Most SPIA quotes offer a payout that's higher than what a laddered portfolio of bonds maturing over someones remaining expected lifespan would pay, and you get the benefit that it's guaranteed to continue even if you live longer than actuarial lifespan tables suggest.
What you don't get, is the ability to "rebalance" if you're a MPT junkie... but it might prevent you from making some behavioral mistake.

Something else I've noticed, which may imply something contrary to the typical advice of waiting until you're really old to get a SPIA: As you get older, the age of your "expected" (actuarial table) demise goes up, which decreases the aggregate amount you would expect to receive in payouts the longer you wait to buy one.
Using IRS single life tables, a 50 year old is expected to live 34.2 years ( age 84.2)
a 70 year old is expected to live 17.0 years ( age 87 )
Using an interest rate of 2.3% (current YTM on BND)
An example $100,000 portfolio of bonds amortized out
for 34.2 years (for the 50 year old), would pay $4,255.05 a year * 34.2 years = $145,522.71
for 17.0 years (for the 70 year old), would pay $7,173.65 a year * 17.0 years = $121,952.05

If I use actual annuity quotes, the aggregate expected payout difference from waiting longer looks even worse the older you get, (using quotes for single male in AZ https://www.immediateannuities.com/ )
for a 50 year old = $400 a month = $4,800 a year * 34.2 years = $164,160
for a 70 year old = $599 a month = $7,188 a year * 17.0 years = $122,196

I imagine the large difference for the younger person in the actual annuity quote, is it's the equivalent of having a larger amount of money in longer maturing bonds (higher yield) compounding for a longer period... whereas my simple amortization used the same portfolio/interest rate for both.

[LadyGeek]

This thread is now in the Investing - Theory, News & General forum (theory).

[Dandy]

Annuities purchased in your late 40's while working seems to be a bad idea. The payout rate would likely be extremely low since the company is likely to be paying you to your mid 80's (on average). Compare that to someone who buys the annuity at say age 70. You are also building higher taxable income in your high earning years as well as the years just prior to age 70 to do some Roth conversions maybe at a lower tax bracket.

Immediate annuities have there place but they are income vs being a bond. They allow you to take more risk if you want to because you will need to withdraw less from your assets. But it is best to wait until you are older to get the best value out of an immediate annuity. Other annuities are usually not recommended due to high costs and complex riders.

[dbr]

Considering that I have pensions and SS, I in fact have annuities. The pensions were not a choice (hah!) and we delayed SS to age 70/FRA.

But I don't play off NPV of income streams as if they are bonds. The existence of income streams has an effect on asset allocation. But note the ability of a portfolio to sustain withdrawals over time is not much affected by asset allocation, so the problem is not that simple. The ability of a portfolio to forego withdrawals and maximize growth of wealth is hugely affected by asset allocation. So if pensions and annuities such as SS allow a person to withdraw little from portfolios, that person might take great risk in the portfolio to grow wealth. That person might also go all bonds in the portfolio because withdrawals are so small the portfolio can't fail and the investor wants the certainty of low risk investing.

[beehivehave]

Considering that I have pensions and SS, I in fact have annuities. The pensions were not a choice (hah!) and we delayed SS to age 70/FRA.

But I don't play off NPV of income streams as if they are bonds. The existence of income streams has an effect on asset allocation. But note the ability of a portfolio to sustain withdrawals over time is not much affected by asset allocation, so the problem is not that simple. The ability of a portfolio to forego withdrawals and maximize growth of wealth is hugely affected by asset allocation. So if pensions and annuities such as SS allow a person to withdraw little from portfolios, that person might take great risk in the portfolio to grow wealth. That person might also go all bonds in the portfolio because withdrawals are so small the portfolio can't fail and the investor wants the certainty of low risk investing.

I don't understand it when someone asks how to categorize an annuity as a fixed income asset. A more direct approach for purposes of planning is to just reduce the income needed from other assets, as one should do for pensions and SS, then address AA and associated issues.

[nisiprius]

In some ways they are like "frozen bonds," in other ways they are not. It all depends on your purpose in looking at your asset allocation.

In terms of risk and return, SPIAs are somewhat like bonds. Bonds have little market fluctuations, SPIAs have none; they are low-risk assets. Unlike other proposed "bond surrogates" like rental real estate or dividend stocks, and like bonds, SPIAs are a legal contract, enforceable in court, to pay specified numbers of dollars on specified days.

But there's on big difference. Bond funds and etfs are highly liquid; investment-grade bonds are liquid; SPIAs are totally illiquid.

I think the best way to look at them, as with Social Security, is not to consider them part of your investment portfolio, but subtract their (predictable) future payments from the income that your portfolio must produce.

So, when you add annuities, your portfolio does not become less aggressive, but your overall situation is more conservative because your portfolio does not need to produce as much retirement income. In the roughest sort of way, if you need a 4% withdrawal rate from your portfolio, and you then add an annuity that generates as much income as 1% of your portfolio, now you only need a 3% withdrawal rate from the portfolio.

[dbr]

In some ways they are like "frozen bonds," in other ways they are not. It all depends on your purpose in looking at your asset allocation.

In terms of risk and return, SPIAs are somewhat like bonds. Bonds have little market fluctuations, SPIAs have none; they are low-risk assets. In terms of what you can do with them, bond funds and etfs are highly liquid; investment-grade bonds are liquid; SPIAs are totally illiquid.

I think the best way to look at them, as with Social Security, is not to consider them part of your investment portfolio, but subtract their (predictable) future payments from the income that your portfolio must produce.

So, when you add annuities, your portfolio does not become less aggressive, but your overall situation is more conservative because your portfolio does not need to produce as much retirement income. In the roughest sort of way, if you need a 4% withdrawal rate from your portfolio, and you then add an annuity that generates as much income as 1% of your portfolio, now you only need a 3% withdrawal rate from the portfolio.

Well said. And that means you have the opportunity to grow your wealth by taking great risk for your legacy objectives or you have the opportunity to take less risk and spend more money on a larger yacht or to pay for a better health insurance policy. It is all about what you need and want.

[Horton]

Michael Finke was on a Morningstar podcast a few months ago discussing this topic, amongst other topics:

https://www.morningstar.com/podcasts/the-long-view/23

[mass_biker]

Thank you all.
When framed as "frozen bonds" that makes all the sense in the world.
I've been calculating SWRs on various asset mixes and at various times (i.e. 8 years from now, 15 years, at age 70 etc.).
The presence of an annuity stream (nearer term - certainly before 70 for tax favored plans/RMDs etc.) does tilt me in the direction of more risk in the overall portfolio. When coupled with rental income and other sources of cash (dividend streams etc.) the "ask" of the SWR goes down, and the ability of the rest of the portfolio goes up.
I began to look at annuities nearer term as a way to replace some of my current wage income in a few years if I decide to pack it in; its longer term impact on the needed SWR and the ability to seek more return/take more risk on the overall portfolio is something I'm going to dig into.
'

[Mel Lindauer]

The younger you purchase an SPIA, the more spending power you lose to inflation over the course of the payouts.

[JoMoney]

A bond portfolios potential withdrawal rate (of principal and interest) amortized out would also start losing spending power to inflation the earlier you start spending it down. So I don't see that as a unique factor that's any different between bonds/SPIA. As long as you need to be receiving payments immediately, I think they're very comparable. If you don't need the income, a SPIA is a horrible choice.

[Mel Lindauer]

A bond portfolios potential withdrawal rate (of principal and interest) amortized out would also start losing spending power to inflation the earlier you start spending it down. So I don't see that as a unique factor that's any different between bonds/SPIA. As long as you need to be receiving payments immediately, I think they're very comparable. If you don't need the income, a SPIA is a horrible choice.

With a traditional portfolio, one can buy I Bonds and TIPS which offer inflation protection. That's rarely available in an SPIA and would greatly redice the payaouts if it were available.

[Stormbringer]

I like the idea of dividing expenses into two buckets:

• Things I need.
• Things I want.

Then, fund things I need with guaranteed income such as social security, pensions and annuities, preferably with some sort of inflation adjustment. Things I want are optional, and therefore can be funded with riskier (stocks) investments.

[capjak]

I think SPIA can be a bond alternative, however, I am not a fan of deferred annuity. I would put the money in a bond/TIPS to mature when I was at a later age (60/70/80, you decide) and than use that money to purchase the annuity if I was still inclined to purchase one. I would use other assets to protect for inflation and only use a smaller portion for the purchase of a SPIA.